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SCOTUS Holds Licensee May Continue Using Trademark After Rejection in Bankruptcy

Insight Douglas J. Schneller Douglas J. Schneller · June 11, 2019

The Supreme Court of the United States has ruled that the rejection in bankruptcy by a debtor-licensor of an executory trademark license does not terminate the licensee’s right to use the trademark but instead has the same effect as a breach of that contract outside of bankruptcy.[1] Consequently, the licensee may continue to use the trademark following rejection. As explained by Justice Elena Kagan, “A rejection breaches a contract but does not rescind it.”[2]

Tempnology manufactured clothing and granted Mission an exclusive license to distribute certain products made by Tempnology and a non-exclusive license to use the relevant trademarks. Before the expiration of the licensing agreement with Mission, Tempnology filed for bankruptcy and sought to reject the licensing agreement under Section 365(a) of the Bankruptcy Code.

Section 365(a) permits a trustee or debtor-in-possession, subject to court approval, to “assume or reject any executory contract.”[3] A contract is executory if “performance remains due to some extent on both sides.”[4] Bankruptcy Code Section 365(g) provides that “the rejection of an executory contract[ ] constitutes a breach of such contract.” Such breach is deemed to occur immediately prior to the filing of the bankruptcy petition, which means that the non-rejecting counterparty will have a prepetition unsecured claim.[5]

The parties agreed that, when Tempnology rejected the license agreement with Mission, Tempnology could stop performing under the contract and Mission could assert a pre-petition claim in the bankruptcy for damages resulting from Tempnology’s nonperformance. However, Tempnology also believed that its rejection of the licensing agreement meant that Mission could no longer use the trademarks.

The Bankruptcy Court agreed with Tempnology and held that rejection of the licensing agreement revoked Mission’s right to use the marks.[6]

The Bankruptcy Appellate Panel reversed the Bankruptcy Court[7], relying on reasoning in a prominent Seventh Circuit case, Sunbeam Products, Inc. v. Chicago Am. Mfg., LLC[8]. The Panel explained that, under Section 365(g), rejection of a contract “constitutes a breach” and that, outside of bankruptcy, a breach does not eliminate rights the contract had already conferred on the non-breaching party, so neither could a rejection in bankruptcy. Rather, rejection “convert[s]” a “debtor’s unfulfilled obligations” to a pre-petition damages claim, but does not “terminate the contract” or “vaporize[ ]” the counterparty’s rights.[9] Consequently Mission would be able to continue using the marks.

However, on appeal, the First Circuit rejected the view of the Panel and the Seventh Circuit in Sunbeam and reinstated the bankruptcy court decision that had terminated Tempnology’s license.[10]

The Supreme Court granted certiorari to resolve the split between the First and Seventh Circuits. In an 8-1 decision, the Supreme Court affirmed the Seventh Circuit’s reasoning and reversed the First Circuit’s decision. The majority held that “under Section 365, a debtor’s rejection of an executory contract in bankruptcy has the same effect as a breach outside bankruptcy. Such an act cannot rescind rights that the contract previously granted.”[11]

Justice Sonia Sotomayor, who joined the majority opinion in full, wrote a separate concurrence that the Supreme Court’s decision “does not decide that every trademark licensee has the unfettered right to continue using licensed marks postrejection. … [T]he baseline inquiry remains whether the licensee’s rights would survive a breach under applicable nonbankruptcy law. Special terms in a licensing contract or state law could bear on that question in individual cases.”[12]

Justice Neil Gorsuch wrote the lone dissent. He would have dismissed the petition for certiorari as “improvidently granted” explaining that “[a]fter the bankruptcy court ruled, the license agreement expired by its own terms, so nothing we might say here could restore Mission’s ability to use Tempnology’s trademarks.”[13]

The Tempnology decision provides certainty for trademark licensees that the bankruptcy of the licensor will not disrupt its business. However, a debtor-licensor’s decision to assume or reject a trademark licensing agreement may now be more complicated, and will also require the debtor-licensor to continue, among other things, to monitor the use of the mark. Fundamentally, however, the rights of licensor and licensee will continue to be governed by the specific contract and applicable nonbankruptcy law. In the wake of Tempnology, therefore, market participants will want to consider carefully various provisions in their licensing agreements, including those having to do with exclusivity, termination and remedies following a breach.

 

[1] Mission Product Holdings Inc. v. Tempnology LLC, 17-1657, 587 U.S. __ (2019) (“Tempnology”).

[2] Tempnology, 17-1657 at 1.

[3] 11 U.S.C. § 365(a).

[4] NLRB v. Bildisco & Bildisco, 465 U.S. 513, 522 n. 6 (1984) (internal quotation marks omitted).

[5] 11 U.S.C. § 365(g)(1).

[6] In re Tempnology, LLC, 541 B.R. 1, 7 (Bkrtcy. N.H. 2015).

[7] In re Tempnology, LLC, 559 B.R. 809, 820-823 (B.A.P. 1st Cir. 2016).

[8] Sunbeam Products, Inc. v. Chicago Am. Mfg., LLC, 686 F.3d 372, 376-377 (7th Cir. 2012). Sunbeam rejected the approach taken in a controversial Fourth Circuit decision, Lubrizol Enterprises Inc. v. Richmond Metal Finishers Inc., 756 F.2d 1043 (4th Cir. 1985). In Lubrizol, the Fourth Circuit held that rejection by debtor-licensor of an executory license for intellectual property means that the licensee could not continue to use the license. After Lubrizol, the Bankruptcy Code was amended to allow a licensee the option to retain its intellectual property rights following rejection during the duration of the contract. 11 U.S.C. § 365(n). Unfortunately, however, the definition of “intellectual property” in Section 101(35A) of the Bankruptcy Code does not include trademarks.

[9] In re Tempnology, LLC, 559 B.R. at 822, quoting Sunbeam, 686 F.3d at 377.

[10] In re Tempnology, LLC, 879 F.3d 389 (1st Cir. 2018).

[11] Tempnology, 17-1657 at 16-17.

[12] Id. at 18.

[13] Id. at 20.

Nothing contained herein is to be considered as the rendering of legal advice for specific cases or circumstances. The material herein is intended for educational and informational purposes only.


Douglas Schneller handles a broad range of complex transactional matters involving bank finance and lending; restructuring, bankruptcy and insolvency; inter-creditor and subordination arrangements, including for mezzanine, leveraged, multi-lien and unitranche financings; claims analysis and reconciliation; and purchases and sales of par and distressed assets such as bank loans, notes, accounts receivable, trade claims, bankruptcy claims, and equity interests. Read more about Douglas.